Don't Bank On It

NINJA Days are Numbered for Commercial Borrowers

Larry Warren

August 1, 2008

Steve Peterson, managing partner of Salt Lake City-based Millrock Development, remembers trying to raise money a couple of years ago for a building project. “One lender would try to outbid the other,” he recalls. “Dozens of people were pounding on doors offering aggressive terms to get our business.” For small to medium companies looking to expand it wasn’t too much different than the sub-prime practices of residential real estate over the past few years. Such was the era of NINJA (No Income, No Job, No Assets) loans, which meant it was fairly easy for just about anyone to qualify for a loan.
Today, the lending landscape has completely changed, and most in the business of lending or borrowing capital for business expansion aren’t sorry to see the “Wild West” lending practices of recent years go the way of yesterday’s pizza. “Capitalism is ruthlessly efficient,” observes Rick Beard, president of the Bank of American Fork. “It will take care of the excesses.”
Today, financing a business expansion, a new building or a new land development can still be done, but funding-seekers must expect to bring far more to the table. Lenders are no longer knocking on doors. Instead, they’re taking a harder look at business plans, balance sheets, track records and such quaint notions as pre-leasing progress or owner-occupied construction. “The whole credit market has seized up to some degree,” Beard says. “There’s a fear in the market that causes everyone to be conservative. Regulators are clamping down on banks and banks are clamping down on their customers.”
Even though the Utah economy remains among the strongest in the nation, there are good reasons for clamping down locally as well. In May, federal bank regulators shut down St. George’s ANB Financial, an Arkansas-chartered bank, primarily due to heavy losses in Utah and Arkansas real estate loans. “Regulators are very bearish on where this is all going,” Beard says. “They’re trying to look at banks and give banks reality checks. They’re very cautious right now—I’m very cautious right now.”
Wells Fargo Economist Kelly Matthews agrees. “The pendulum of understanding and evaluating risk got way out of whack,” he says. “Now the pendulum has gone beyond what is normal to overly cautious. No financial institution wants to find themselves with borrowers who have serious difficulty making payments.”
For those in the market for loans, that means real and substantial changes going forward. Lenders are more selective and are demanding that borrowers put more of their own assets into the project. Mark Bouchard, managing director of CB Richard Ellis says, “Over the last few years, you could get into projects with 15 percent to 20 percent equity. A good strong project today requires 30 percent to 40 percent equity. The dynamics have changed.”
Peterson says his timing was impeccable when he borrowed $100 million from the Bank of America to build Millrock Park, a 22-acre campus of Class A office space adjoining Old Mill Golf Course in Holladay. “We hit the market right.” he says. “If I were to try to build it going forward, it wouldn’t happen.” Also, as banks get more conservative, developers turn to other cash sources, such as pension funds and insurance companies. Loan money has not dried up, but the underwriting criteria have. Today, in addition to bringing far more equity to the table, borrowers have to be more realistic about their projects. “The characters who are dreamers—it gets those guys out of the way,” says Steve Bogden, the Utah-based national director of business development for Coldwell Banker Commercial. “A market like this hurts the speculator who’s buying 10 to 20 houses and flipping them—they’re gone. They’re not astute business people.”
Instead, lenders are looking for experienced borrowers with whom they have a track record. “Good deals always get money,” says Ray Walker of CBRE Melody, the finance arm of CBRE. “I don’t have a single loan in trouble.” Commercial lenders, who sat out the lending frenzy of NINJA loans as Walker did, still have money for projects like apartments, office buildings, retail and industrial, as long as the projects deliver cash flow that will service the debt. Lenders are looking at preleasing rates as an indicator the buildings will have a positive cash flow from the day the ribbon is cut.
“Apartments are one of the best investments now,” reports Coldwell Banker’s Steve Bogden. Homebuyers who are not qualifying for the suddenly more stringent residential loans are filling them up. Tenants for Class A office space in prime Salt Lake Valley locations are lined up for buildings as they come on line. But new retail space is slower to fill than offices and apartments. “Tenants are holding off,” Bogden says. “Big department stores have to keep growing,” he notes, but are being more selective in where and how that growth occurs. “They’re going to take the biggest markets, the best deals. They’ll take longer at negotiations pushing for every consideration they can get, and they’ve got the time to do it because they’re (building) fewer stores.”
The shakeout is beneficial for the most part. “The market has tightened, there’s a flight to quality, projects are still being financed,” CBRE’s Bouchard notes. But now, investors are spending more time on the sidelines, putting together investment pools to come up with the higher levels of equity required and the business plans to make sure they’ll meet the closer scrutiny of lenders.
Will the risk pendulum swing back from what many think is its overreaction to the sub-prime debacle? Like all economic cycles, it will take time. “Businesses are slimming down and getting ready to get through this,” Beard observes. “There’s a natural order of things,” Bouchard adds. “Not as many projects are coming out of the ground, but that’s not a negative thing—it balances the market out.”
It is survival of the fittest. Less experienced developers, speculators and those who are not as well capitalized are having a tough time. Those who have projects that continue to make sense, and have strong backers and balance sheets, go forward.
And there are always better times ahead. Bogden is full of optimism, having just returned from a major international shopping center convention. “I think the election is going to do wonders,” he predicts. “2009 will be slow in new (store) openings, but all heck will break out in 2010 and 2011. It’ll go crazy.”
So watch out again for that swinging pendulum.